A Tech Turnaround in the Making

07/03/2013 9:45 am EST


Investors don't get too many opportunities to buy a technology company as this stage, but here's your chance, says Michael Robinson of Money Morning.

High-potential tech turnarounds don't come along that often, and can be tough to find. But the payoff can be well worth the search.

Tech turnarounds are tech firms that missed a major market shift, were late debuting a key product, or that stayed with the same manufacturing process long after it was profitable. They committed strategic miscues or tactical missteps, and their share prices have been clobbered as a result.

Take FormFactor (FORM), the specialty supplier of test equipment to semiconductor firms, which trades at about $6.65 a share.

However, the true cost of buying FORM is closer to $4, because the firm has $196 million cash on hand and almost no debt, giving it a net cash per share of $2.75...lowering your "true cost" by about 40%.

Why the discount? FormFactor's stock sank in late 2009, after the International Trade Commission ruled that two competing firms had not infringed FormFactor's patents. It then reported losses amid a weak economy.

But investors are catching on to the turnaround story, recently sending shares up nearly 35%. And it still has plenty of upside. If it just got back to half its five-year high of $25.67, set on September 7, 2009, it could hit $12.84-for gains of more than 90%.

FormFactor also meets the four basic criteria or "screens" that I use to judge turnaround candidates:

When a company needs to go in a new direction, it has a much better chance at success if there's new blood at the top. New execs bring fresh ideas and new approaches with them, and aren't hobbled by old alliances at the firm.

In 2010, the company hired outsider and tech-sector veteran Thomas St. Dennis as its savvy new CEO. He brought in an entire new senior management team.

Then, to convince key customers, lenders, and investors that a once-troubled firm is on a new path, it has to have something concrete to offer—like new products, new markets, or better ways of doing business.

FormFactor did all three by pulling off a big merger with MicroProbe, which made FormFactor the semiconductor industry's largest supplier of test-probe cards, the specially designed electronic cards used to check the quality of circuits in silicon chips.

Also, FormFactor's finances are improving. Its balance sheet is still a mess, but it is making progress, restructuring operations to slash operating costs while getting products to market faster. Over the last ten quarters, FormFactor has lowered operating expenses by roughly 35%.

FormFactor also spent $4 million on restructuring charges, a common expense for turnarounds. Outlays like this are referred to by Wall Street as "one-timers," because they aren't part of the ongoing cost structure of the business. Sales soared 51% in the first quarter.

FormFactor has one more key factor: new growth. The recent MicroProbe merger moved it into the growth market for mobile devices. Smartphones and tablets are outselling PCs by a ratio of nearly 5:1.

Chips for this segment are much simpler than the ones used in PCs. That allows FormFactor to make less complex—and much cheaper—test cards to serve a rapidly growing market. The firm expects its mobile test products to grow from the 17% of sales it represented last year to 50%.

Clearly, FormFactor is making all the right moves. But since turnarounds carry more risk, I suggest that you take steps to add a margin of safety to any investment you make. For instance, if you generally put no more than 5% in a single position, I would limit a trade like this to 2%.

You can also average in by starting with a smaller position, and adding to it over regular intervals. And limit your losses by using trailing stops and stop-losses.

The gains from these kinds of stocks can be dramatic-and can come quickly.

Read the rest of Michael Robinson's "Here's the Secret to Uncover 'Hidden' Tech Winners" at Money Morning.

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